Why Fitch’s Downgrade Matters

Fitch Ratings’ decision to strip the U.S. of its triple-A credit rating last week was widely dismissed as meaningless. After all, Standard & Poor’s had done the same back in 2011 and bond yields declined—implying more, not less, appetite for Treasury debt.

This time, though, bond yields rose. That suggests Fitch’s action deserves our attention, not because it tells us anything new but because it joins the stack of evidence of how profoundly different, and risky, the nation’s fiscal situation is now.

The risk isn’t of a debt crisis that locks the U.S. out of the markets, as happened to Greece in 2010 or Mexico in 1994; that is virtually impossible for a mature country that borrows in its own currency. The risk, rather, is of deficits and interest rates feeding back on each other at growing cost to both economic growth and taxpayers.

Federal budget deficits can’t be viewed in isolation. When S&P downgraded the U.S. back in 2011, the deficit was equivalent to 8.4% of gross domestic product, close to a post-World War II high. But in the wake of the 2007-09 recession, such deficits were both easy to finance and necessary. Private investment was subdued, unemployment at 9%, underlying inflation below the Federal Reserve’s 2% target and interest rates stuck at around zero.